Balance between Liquidity and efficiency management in Financial Intermediation

There is serious concern on leverage of financial intermediaries which RBI sees as systemic risk. The system at this stage is well-balanced at the shorter end (up to 30 days) of ALM profile; most PSU banks being the source (lenders in call money market, maintaining positive gap in 1-28 days time buckets), and Private/Foreign banks as the users of funds through short term liability products of Call/CBLO/CDs and sale of assets with or without pass-through of credit risk through judicious management of negative gap in 1-28 days time buckets. The going is good on the system as whole with Banks holding around 28-30% of NDTL as against mandatory 22% SLR. This stance is reflected in higher efficiency ratios of Private/Foreign banks versus Public sector banks measured against Return on Assets (and Equity), hence higher multiplier on Price to Book and P/E multiple for private banks. If SLR/CRR holding is reckoned for LCR, there is no major risk in play, and RBI allowing dip in to SLR of upto 5% of NDTL is step in the right direction to balance efficiency with prudent liquidity management.

Banks do encounter serious constraints in managing ALM gaps and to insulate margin risk from interest rate sensitive gaps from mismatch in fixed/floating assets/liabilities. The demand for fixed rate long term funds is much higher to availability of fixed rate long term liabilities; so, Banks are forced to fund long term assets through short term liabilities, not by design. There is no efficient IRS markets for Banks to close interest rate sensitive gaps. All taken, RBI should ensure to provide suitable environment for Banks to manage LCR without impact on efficiency margins by removing restrictions on accessing long term liability products and market platforms for efficient management of related market risk.

Most banks do understand the benefits of cutting the leverage, and manage judiciously through higher capital adequacy ratio and take on asset products which consume lower risk-weight. Banks have now learned the art of managing LCR through behaviour modelling; higher percentage of CASA outflows pulled-out and higher share of working capital repayments pulled-in, along with excess SLR and capital funds. The pressure on LCR is from build-up long term assets through long term loans to  infrastructure, funding leverage of capital expenditure and Home loans. RBI does discourage Banks from these asset classes in the absence of back-to-back liability profile, but given the pressure on top-line growth, Banks find it tough to manage combine impact of growth, LCR and risk-adjusted returns.

There is lot to do by the regulators before Banks are mandated to maintain near-zero gap in the shorter end of ALM profile. It is good to be efficient but there should be ways and means to stay efficient on liquidity with minimal damage on efficiency, which generates money to the exchequer and investors!

Moses Harding

RBI keeps eyes on inflation and ears on external impact on expectation!

Raghu Rajan retains the rhythm on monetary policy tunes!

Policy rates unchanged and liquidity retained, but 2% of NDTL to be released in phases on baby-steps reduction in HTM to be at par with SLR by end of 2015. No significant impact on Money/Bond markets: Short term Money Market curve to stay elevated and 10Y Bond yield at upper-half of long term focus zone of 8.15-8.65%. The policy has done no major favours to Equity and Rupee. While there is no reason to review NIFTY trading range from 7850/7900-8150/8200, Rupee is at risk of adjusting to part of time-decay for shift of focus from 60-62 to 61-63 into mid 2015. This is seen as win-win for all stake-holders, importers & foreign currency borrowers on one side and exporters & foreign currency investors on the other side. It will also result in avoidance of excessive one-way build-up of open exposures.

Bottom-line (and take-away) is that shift into dovish monetary policy stance is not round the corner and Rupee reflecting the REER in alignment with dollar value against EM currencies seen to be the preference without getting into target seting.

Overall, RBI's stance is sensible with no urgency to be seen as bold and aggressive! Being conservative (and cautiously passive) till feet firm on the ground is the street-smart character of Raghuram Rajan!

Moses Harding

Rupee nervous from extended dollar strength!

DXY at 85.25-86.25 seen as best case on rally from below 80; beyond here will be pain for many and cheer for some! Tracking the dollar strength, Euro is down from 1.40 to 1.27, JPY from 101 to 109 with similar impact on most of EM currencies. Rupee has stood out with marginal decline from 60.20 to 61.70. RBI is playing both sides to balance expectations of exporters/FC investors (with $ bids above 60.20) and importers/FC borrowers (with $ supply below 61.70). Will RBI retain this "peg" at 60.20-61.70 or prefer a "floating peg" in line with REER?

What next? It is high probability that 60-63 is the range for USD/INR till March 2015. The doubt is on the direction of NT stability either at 60.00-61.50 or 61.50-63.00! While domestic (and emerging external) cues are mostly priced-in, break-out direction of DXY at 85.25-86.25 will set up the bias; extended $ rally beyond 86.25 puts Rupee at risk of shift into 61.50-63.00 range while sharp correction below 85.25 (with extended pause) is relief for Rupee at 60.00/60.50-61.50! It is all-win stance if Rupee stay adjusted to time-decay with baby-steps move within 60-62/63.

Moses Harding

Will RBI deliver unexpected - pleasant or otherwise?!

Stake-holders are unanimous on "no change" on policy rates but uncertain on SLR/CRR! There is fear of cut in SLR (and HTM) and hike in CRR as inflation management strategy to retain tight liquidity and elevated money market rates and bond yields.

10Y bond yield has priced-in this fear with marginal spike from below 8.45% to 8.50%. Equity markets at risk of money chasing elevated rates (and yields) in Gilts/Corporate bonds. Rupee retain its support from interest rate play (through higher premium) restricting forward dollar demand upto 1-3 months but pulling in 3-12M exporter's supply on spot weakness into 61.45-61.70.

Post - policy price stability!

RBI may not like to spoil the "NaMo-US" party with "unpleasant surprises" (and when the FM is not in good physical shape); so choice is between delivering to expectation or pull-in surprises, with no HTM cut and no CRR hike! RBI will remind the tracker zone of 6-8% on CPI and 5-7% on GDP for rate/liquidity guidance. At this stage, there is comfort on GDP trend into 7% but lack of optimism on CPI trend into 6%; the need for RBI is to be more watchful on the inflation!

All taken, pre & post-policy range is seen restricted! 10Y bond yield at 8.40/8.45-8.55/8.60%; NIFTY at 7850/7900-8100/8150 and Rupee at 61-62.

Happy holidays!

Moses Harding

Retain non - euphoric optimism!

Sensible move by S&P:

The upgrade in outlook was over-due! It does not make sense to retain negative outlook when the attention of global investors is on India. The operating environment has changed significantly since Modi taking guard at the Centre. There have been many lofted shots to the boundary in the first few overs! The screams (and chants) from the gallery are loud and the world is taking note of emerging business opportunities in India. The engagement within Asia-Pacific region is encouraging. Modi's visit to the US will emerge as India leading the connect between East and the West for building linkages for mutual benefits. Bottom-line line is to make the western monies to chase opportunities in India! All taken, there is no reason for global rating agencies to be negative on India; S&P was alone and joining with others is not a surprise, although bit too late! The timing of S&P shift to stable outlook is perfect when Indian asset classes were under pressure for break-down! Now, global rating agencies are unanimous on Indian economic prospects with stable (to positive) outlook and stay in preparedness for upgrade if Modi Government deliver to expectations!

Factors leading to upgrade in 2015:

The foundation is firm now; there is political majority, decisive leadership and consensus approach with opposition parties and non-NDA state governments. The concerns from policy paralysis, regulatory irritants and administrative bottlenecks are behind. Modi's mantra is to deliver effective and good governance building skills, speed and scale. All these should lead to (a) India emerging as a great place to do business and (b) ensure good (and steady) long term returns for the investors. Global rating agencies will keenly watch the beneficial impact on macroeconomic fundamentals. The immediate focus will be on the following for FY15:

(a) step-up in GDP growth momentum to over 5.5%

(b) Control of fiscal deficit at sub 4%

(c) Steady CPI inflation at 6-7%

(d) Exchange rate stability with control on the CAD without heavy dependence on hot-money FII flows to fund deficit

No doubt, the "bar" is lifted up but not seen as ambitious given the pent-up momentum. The hope (and optimism) of upgrade in India sovereign rating is firmly on the radar and leading the action into first half of 2015 is the immediate agenda for Modi and his team!

Impact on Indian markets:

I retain the set strategic focus trading zones set for the short term, rest of 2014.

Retain NIFTY focus at 7700/7850-8150/8300. Having already seen back-and-forth moves in quick-time, momentum now will be into higher end, and prepare for shift into higher focus zone at 8000/8100-8400/8500 at start of 2015 and for more, if all goes well with attention on Budget FY16.

Retain Rupee focus at 60.20-61.70; here again, have seen back-and-forth moves in quick time retaining the bullish undertone on the way forward despite firm USD against global currencies. India growth story, sustainable bearish undertone of commodities, robust foreign currency inflows and dollar supply-driven mode in forward market (diluting importer's fear while retaining high-premium advantage to exporters) will dilute the strong dollar impact on Rupee, emerging as one of the stronger currencies of the world. All taken, end Mar'15 $ has strong resistance at 64 and 12M $ at 66.50, good enough for exporters when spot USD/INR is expected to stay steady at 60-63 for the next 6-12 months.

RBI is expected to stay neutral on policy rates (and tight on liquidity) for the next 6-12 months till structural woes on growth-inflation dynamics are resolved. The shift to dovish stance will be dependent on FED momentum on rate-hike cycle and down-trend momentum in CPI into/below 6%. Retain 12M focus on 10Y bond yield at 8.15-8.65% and not sure at this stage on stability at 8.15-8.40% or 8.40-8.65%. But given the optimism on twin-deficits and exchange rate stability, bias will be on stability around 8.40% given the risks from supply-side and pipe-line SLR/HTM reductions.

All taken, there are no reasons to stay negative on Indian asset markets and allow stability till clarity on policy legislation and on-ground execution to convert the pent-up optimism into ground reality, and to step up across-the-pyramid economic and social well-being!

The country is in the able hands of Narendra Modi, Arun Jaitley and Raghuram Rajan; the combined strength of the trio brings the confidence to domestic (and foreign) stake holders; they all know it is a make-or-break opportunity to either elevate India status in the global arena or stay insignificant into next generation!

At this stage, it is prudent to stay positive and be overweight on India!

Moses Harding

Monetary Policy expectations:

Comfort on growth, suspect on inflation:

There is lot of hope, euophoria and optimism in step-up of GDP growth momentum. The set target of 5.5% for FY15, 6.25% for FY16 and over 7% by March 2017 is believed to be realistic not ruling out exceeding expectation. On the other hand, inflation-push factors stand diluted with sharp reversal in Brent Crude from over $115 to below $98 and long term Rupee stability at 60-63 with an acceptable 3% annualised depreciation to support exports and "make in India" campaign. The only (but major) concern is from supply-side worries on essential items which keep CPI at elevated rate without taking into account growth-push impact on inflation. RBI has set CPI target range of 6-8%, leaving 3 possibilities: (a) rate hike if over 8%; (b) rate-pause at 7-8% and (c) liquidity easing while at 6-7%. All taken, domestic cues have improved to dilute the conflicts in growth-inflation dynamics which caused RBI and FM to walk in different directions!

External cues not in favour:

FED is seen to start the rate-hike cycle by mid 2015 while ECB in extended ultra-dovish policy stance. This is minor relief but will cut RBI's band-width to turn ultra-dovish; significant squeeze in yield differential (at elevated CAD and inflation) will trigger accelerated Rupee weakness. There is need to manage interest rate and its impact on exchange rate to avoid emergence of growth-inflation conflicts. The comfort on availability of external liquidity is from emergence of India as the most favoured emerging market when opportunities are few in China, Russia and developed economies. All taken, while there are no downside risks, RBI might need to stay neutral (at best, mildly dovish) for extended period of time till shift of CPI target zone to 4-6% and sharp trend-down in twin-deficits.

Liquidity (and cost of liquidity) is the tool:

The intent of RBI is to retain operating policy rate at higher end of Repo-MSF corridor (currently at 8-9%) till comfort on inflation and twin-deficits with an agenda to keep Rupee exchange rate (above REER) attractive to exporters and FDI/FII inflows. At this stage (into busy season), liquidity is very comfortable with effective over-night rate at 8%, which is against RBI's scheme of agenda. There is downward pressure on shorter end of the rate/yield curve with flat 1-10 year curve around 8.5%. It is also fact that Banks hold huge excess SLR despite bringing the limit to 22% and retaining HTM at 24% defies logic! The excess SLR amounting to over Rs. 3-4 Trillion need to be pushed into the system for productive deployment. Bottom-line is that system liquidity is in plenty but credit-worthy opportunities are few! The immediate task for RBI is to push effective policy rate into upper-half of 8-9% through either suck-out of excess liquidity or through rate hike.

Policy expectations & impact:

1. Status-quo on policy rates with mild hawkish stone for either extended pause or movement either-way in alignment with CPI movement and directional bias. Impact is neutral to mildly bearish on equities & bonds and supportive to Rupee.

2. Status-quo on SLR with 50 bps cut in HTM from 24 to 23.5%. Impact is bond-negative, Rupee supportive and neutral on equities.

3. 50:50 probability between Status-quo in CRR and 50 bps hike from 4.0 to 4.5% with objective to push over-night rate into 8.5-9%. Impact is negative on Bonds, neutral on equities and supportive to Rupee.

4. Lots to be done on flow of liquidity to infrastructure, manufacturing and agriculture to support Government's initiative to step-up all-round growth momentum. More to hear on development of vibrant bond market as alternate financing channel and to reduce pressure on commercial banks. Huge monies on tap with domestic Insurance, Provident & Pension Funds, ultra-high net worth individuals & Family Offices/Trusts and off-shore institutional investors. Financial Inclusion is another agenda where entities are ready to extend spoke support (for reach-out to bottom of the pyramid) from the last-mile hub branches of financial entities. Impact on markets will be positive as these measures will improve productivity and efficiency for uplift of economic and social well-being!

As the "talk" is getting louder with attention in plenty, RBI support to walk-the-talk will be keenly watched on how financial services will be geared to meet expectations. There is huge expectation from the RBI Governor with confidence that Dr.Rajan will do the best managing (and balancing) the expectations of stake-holders. Good luck, Raghu Rajan!

Moses Harding

Rupee unlikely to breach 63/Dollar - NDTV Profit - 7th August, 2014

http://profit.ndtv.com/videos/news/video-rupee-unlikely-to-breach-63-dollar-moses-harding-333185

Bankers Talk - Infrastructure Today - August 2014

http://www.infrastructuretoday.co.in/News.aspx?nId=c9jCzGEGSd7nmRVxwS0t+Q==

Focus on macroeconomic fundamentals

FOMC and Scottish referendum is out of the way without any impact! The developments (mainly from diluted hawkish tone of FED) and Euro zone uncertainties have added strength to the US equities, bonds and currency, not only into the near term but also for extended period of time. The risk-on investor sentiment is no relief to commodity assets with only support from short-squeeze and minimal hedge-play! The global impact on Indian markets is mixed given the recent bull-run across asset classes, with move either-way remaining shallow! The worry from geo-political tensions in Russia and Middle East remain valid but not seen to have major impact on financial markets. The trigger for directional bias will be from economic data print which is also not expected to provide pleasant or unpleasant surprises and to expectation. All taken, markets will stay sideways for the week with mild bullish momentum.

Trading range for the week:

NIFTY continues to struggle at strong resistance and "no-buy" zone of 8150-8200/8300 while strong bounce back from 7925 add confidence to the bulls. There are no strong cues to review the set NT focus zone of 7850/7900-8150/8200; good risk-reward to play end-to-end and not favourable risk for chase beyond 8150-8200.

Rupee boxed at 60.70-61.20 (within big picture range of 60.20-61.70) with good hedge interest at both ends. The break-out bias however is for extended weakness into 61.45/61.70 in the near term. Retain focus for end Mar'15 $ at 63.00/63.15-63.85/64.00; break-out either-way not expected to sustain. Retain hedge strategy to hedge 15-30 day imports at forward rate of sub 61.00 and exporters to cover 12M $ at 66.15-66.40.

10Y bond is in back-and-forth mode at 8.40/8.45-8.55/8.60% and likely to stay here for extended period. As per script, bond spread with US 10Y yield is squeezed from 6.20-6.35% to 5.80% with US 10Y yield spike from 2.30-2.35% to 2.55-2.65%. There are no major risk from domestic cues with improved outlook on inflation, ample liquidity and surplus cash with the Government. All taken, 8.40% 2024 bond is seen sideways at 8.40-8.50% at 5.85-5.90% spread with the US 10Y seen in consolidation mode at 2.55-2.65%. 10Y benchmark bond into premium (below 8.40%) may not have investor appetite.

DXY retains bullish undertone for extended rally over 84.75 into/over 86.00 with strong base at 83.85-84.00. Euro retains bearish momentum into 1.2650-1.2750 (resistance around 1.29) while USD/JPY extend lead into 110.65 with strong base at 107.25-107.50.

Brent Crude in consolidation mode around 98 (within 95/96-99/100) post the sharp fall from strategic sell zone of 115. Retain strategic consolidation now at 85-100 (favourable shift from earlier focus zone of 100-115).

Gold at striking distance at 1185-1200 to complete the chase from 1330-1345. Prefer near term stability at 1185/1200-1240 (trail stop at 1241).

Have a great week ahead!

Moses Harding

Rupee to be at REER till all-is-well

Most cues have turned in favour of the Rupee; most important are the sharp reversal in Brent Crude and Gold reducing the pressure on the CAD, robust FII/FDI/ECB flows through capital account, both combined keeping the Balance of Payment in favour to keep the market in dollar supply-driven mode. The risk from FED hawkish stance and its preparedness for shift into rate-hike cycle in 2015 and resultant worry of FII pull-out or dilution in off-shore inflows is significantly diluted by contra-stance of ECB with extended ultra-dovish monetary policy stance. All taken, there is no major risk of emergence of external headwinds against Rupee.

Domestic cues are very positive with expectation of significant improvement in macroeconomic fundamentals, diluting growth-inflation conflict. The worry on fiscal deficit is behind with pass-through of subsidies and revenue pick-up from disinvestment. While GDP growth momentum is seen to be in place, inflation-push factors from twin-deficit stay diluted. Supply-side concerns are not very relevant on capacity expansion bridging demand-supply gap and adequate monsoon. All taken, domestic cues stay supportive to Rupee.

Is the Rupee good for long term? There are serious structural issues that can pull the trigger against Rupee on any minor shock - domestic or external. There is need to keep Rupee exchange rate attractive till CAD woes are completely resolved. Till then, Rupee should be supportive to exports, restrictive to consumption of non-essential imports and attractive to off-shore inflows. The dollar reserves with RBI constitute hot-money FII flows with the need to ring-fence through strong dollar and elevated interest rate. The best option to manage domestic & external supportive cues against the structural imbalance is to administer Rupee exchange rate above REER which is moving above 60 tracking the dollar strength against major and emerging market currencies. The ideal 1 year range for Rupee is at 60-63 which is seen as win-all for all stake holders till Indian economy gets into high growth-low inflation position and squeeze in import-export gap for being less dependent on hot-money, fair-weather FII flows. 1Y target for Rupee is seen at 62, close to estimated REER retaining long-term bullish momentum on the USD.

Moses Harding